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19 Aug 2020

Property fund investors could face a six-month wait to release cash under new rules

The FCA wants to reduce the potential harm to investors in open-ended property funds

Investors in open-ended property funds could have to wait for up to six months to sell down their investments, under proposals from the Financial Conduct Authority (FCA) intended to tackle a 'liquidity mismatch' in the sector.

The FCA wants to reduce the potential harm to investors in open-ended property funds, by requiring them to give notice - potentially up to 180 days - before their investments can be redeemed.

The aim is to avoid mass cash withdrawals, which can lead to widespread fund suspensions like those seen during the coronavirus crisis.

Currently, more than £12.5bn of investor cash is trapped inside open-ended property funds, and investors are continuing to be charged high fees on their frozen assets.

Here, Which? explains how open-ended property funds work, how the FCA is protecting consumers and whether investing in property funds is a good idea.

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How property funds work

Property funds are investments in commercial property - for example, offices, factories, warehouses and retail space. Customers make lump-sum investments, which are pooled together and used to buy a range of assets.

Property funds can be structured in two key ways: open-ended funds such as open-ended investment companies, and closed-ended funds such as property trusts.

Open-ended funds are collective investments that don't have a fixed size or number of units, and shares can generally be issued and redeemed at any time.

These funds grow or shrink in size depending on consumer demand. The price at which these are issued or redeemed varies in proportion to the net asset value of the fund and so directly affects their performance.

Meanwhile, closed-ended funds are overseen by a fund manager and have a fixed number of shares through an investment company. They raise capital by putting out an 'initial public offering', which is the process of offeringshares of a private corporation to thepublic in a new stock issuance.

The prices of shares in a closed-ended fund are determined by market demand and supply factors, rather than with strict reference to the net asset value of the underlying portfolio of assets in the fund.

What are the issues with open-ended property funds?

At present, those who invest in open-ended property funds can buy and sell units on a frequent - often daily - basis. However, the underlying property in which these funds invest can't be bought and sold at the same frequency, which creates a 'liquidity mismatch'.

When too many investors simultaneously redeem investments, a fund manager may need to suspend dealings in the units of the fund because of the liquidity mismatch between the fund units and the underlying property assets, in order to protect investor cash.

Waves of property fund suspensions have been seen since the Brexit referendum in 2016. But the issues with these funds were notably thrown into the spotlight last year after the fallout from the Woodford scandal.

The illiquid nature of property means that a reliable price isn't always readily available, thus making selling such funds more difficult.

How's the FCA tackling the issues?

The FCA says that the repeated suspensions over recent years for liquidity reasons suggests there may be 'wider problems'.

The watchdog is concerned that the current structure could 'disadvantage some investors because it incentivises investors to be the first to exit at times of stress'. It adds that this may potentially harm people who remain if the fund suspends or assets are sold too quickly due to liquidity demands.

The proposed notice period would allow fund managers to plan sales of property assets so that they can better meet redemptions that are requested, the FCA says, adding that it will also enable 'greater efficiency within these products', as managers can allocate more of the fund to property and less to cash for unanticipated redemptions.

FCA interim chief executive Christopher Woolard says: 'We think that our proposals will help further our consumer protection objective by reducing the number of fund suspensions, preventing unsuitable purchases of funds, and by increasing product efficiency for fund managers.

'We want open-ended funds to provide a structure through which investors can safely invest in less liquid assets which offer attractive expected returns and at the same time supports investment that benefits the wider economy.

'We hope the proposed new rules will directly address the liquidity mismatch of these funds making them more resilient during periods of stress, and allowing them to operate in a way that all investors are treated equally.'

The FCA says it will publish a policy statement with final rules 'as soon as possible' in 2021. The consultation remains open to responses until 3 November 2020.

Should you invest in property?

It could be a good idea to include property in your investments as a way of diversifying your portfolio to help reduce the risk to your overall pot.

Investing in property is higher risk than say, bonds - which generally offer fixed returns - because the market is more volatile. This means that, while there is more potential for gains, there is also more potential for losses.

Access to your capital may also be restricted through property funds if closed to redemptions. As it stands, nearly all UK open-ended property funds have been suspended since March. Investors won't have access to their capital until the redemption has been lifted.

According to the Bank of England, even with the implementation of redemption periods, other structures such as closed-ended funds may be more appropriate for investing in illiquid assets like property. In its regular Financial Stability Report published earlier this month it said: 'Relative to open-ended funds, closed-ended funds face a lower risk of having to liquidate asset holdings earlier than planned to help meet redemptions - potentially making them a more suitable vehicle for certain illiquid investments.'

If you're not sure whether property funds are a good option for you, you could talk to a financial adviser.

Although you can invest directly in some funds, it's easier to buy them through an investment platform.

We've reviewed the major UK platforms; you can find our Which? Recommended Providers here.